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Is Arena Pharma Going to Cure Obesity?

Arena Pharmaceuticals (NASDAQ: ARNA) is one of a host of small-cap pharmaceutical companies that hope to make it big in American health care. As is the case with small pharmaceuticals, Arena is constantly fighting to increase the size of its patent portfolio, either to develop its own drugs or license out the patents to other companies. Recently, Piper Jaffray (NYSE: PJC) upgraded Arena Pharma to "Overweight." Does this mean that Arena is a good purchase now?

The primary reasoning for Piper Jaffray's upgrade is a result of Arena's drug Lorcaserin. Lorcaserin is re-submitting its New Drug Application by the end of 2011, and Piper Jaffray believes that Arena's progress may render a positive result. Lorcaserin is a weight-loss drug that acts as an anorectic. Despite the possibilities that may be present with Arena Pharmaceutical's drug, there are adverse side effects concerning the cardiovascular system.

Interestingly, Arena Pharmaceuticals has a number of other drugs that are in the pipeline, but none on the market. They appear to target cardiovascular functions as well as diabetes. While many biotechnology and pharmaceutical firms are in the research and development phase, they cannot last long without producing tangible results. Arena has been around since 2000, which means that it has had over 11 years to come up with some sort of drug to garner tangible revenues. Currently, it records revenues as a result of collaborations with companies like (NYSE: MRK), research funding, and development fees.

What else could make Arena Pharmaceuticals an attractive purchase for investors? So far, it appears to be a fairly risky company that is hoping to make it big with at least one of its drugs. From a qualitative perspective, Arena Pharmaceuticals' approach seems to be attractive from a patient's perspective. The company is seeking to develop oral medications, which is one of the least invasive therapies that exist. Of course, it results in more complications for the scientist trying to perfect and develop the product, but it presents an ideal solution for patients.

Arena Pharmaceuticals is also collaborating with Merck on a drug that targets arteriosclerosis, or the hardening of arteries. Knowing Merck and its long history of patents and collaborations, it seems likely that the drug will eventually be accepted by the FDA, depute only being in the first phase of trials right now. Another one of Arena's drugs, targeting type 2 diabetes, is also being worked on with Ortho-McNeil-Janssen. Given the high amount of collaborations, Arena Pharma may see some success in the near future.

When placing Arena Pharmaceuticals next to its competitors, it may not have the most positive picture. For instance, it is currently trading at higher price/book value and price/sales ratios than its average competitor. It is also at a negative price/earnings - due to negative income figures on an annual basis. As such, it also has a negative return on equity, while the industry average is about 9.2%.

Growth factors like revenue growth and EPS growth are negative for Arena Pharmaceuticals as well, while competitors are operating with positive growth ratios. Arena also has negative operating and net margins, while competitors have positive margins. It seems that the marginal revenue is not compensating for Arena Pharmaceuticals, in the face of research and development expenses along with salaries and marketing expenses. If Arena were to successfully develop and market one of the drugs in its pipeline, Arena may be in a much better position, financially.

Investors need to understand the company from a qualitative and quantitative perspective. Considering that Arena Pharmaceuticals shows some promise but is trading higher than its competitors , investors should take special care to understand everything it has to offer. Investors should also look deeper into Piper Jaffray's comments on the company, as the equity researchers may have developed certain arguments that make perfect sense for their recommendation.

Arena Pharmaceuticals is currently trading at $1.43, down over 16.8% for the year.

ACTION ITEMS:

Bullish View:Traders who believe that Arena Pharmaceuticals is an appropriate long investment might want to consider the following trades:

One of the company's strongest selling points is that is close to completing clinical trials for an obesity-relieving drug.

It is currently collaborating with other large pharmaceuticals, like Merck, on drugs dealing with hypertension and diabetes.

Its revenues based on milestones and collaborative funding have been fairly consistent, indicating continuous work to develop and research drugs.

Bearish:Traders who believe that Arena Pharmaceuticals is more suited for a short play may consider an alternate position:

Arena's stock is trading higher than its competitors, despite the low price. In this sense, it appears to be overvalued.

Arena Pharmaceutical's net income has been negative quarter-over-quarter for several years, indicating that its expenses are increasing but are not tangibly improving its drug development scheme.

The company's research and development efforts appear to be slowing down, from an expense standpoint. This may mean that it is not planning on researching more drugs until its pipeline is freed up and drugs are either definitively approved or denied by the FDA.

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